Indonesia’s growth is set to slow in 2014; and risks remain high. Reversing the slower growth forecast for 2014 will require additional and more focused policy responses. In particular, while policymakers in Indonesia have taken steps to encourage near-term macroeconomic stability, especially through monetary policy and exchange rate adjustments, further structural reforms are needed to support export performance and encourage long-term faster growth.

The final quarter of 2013 ends a year of significant economic and policy adjustment in Indonesia to tighter external constraints, with the Rupiah depreciating by 4 percent over the quarter to 13 December (25 percent year to date), policy rates increasing 25bp (175bp year to date) and new data showing that growth slowed to 5.6 percent year-on-year in Q3.

In 2014, Indonesia is likely to record slower economic growth than in recent years (5.3 percent expected in the base case), and faces significant economic risks. The risks to growth are high as the needed adjustments to weaker external balances continue to play out in the domestic economy, and as a result of shifting economic conditions and policies internationally (notably US Fed “tapering”), which may further tighten external financing conditions.

The monetary policy and exchange rate adjustments seen in 2013 are broadly positive for macroeconomic stability, however, they also carry costs and bring with them risks. Therefore, moving into 2014 the recent, necessary focus on near-term macroeconomic stability should continue to be augmented with more steps to support a virtuous cycle of strong investment, including foreign investment, and output growth.

To achieve this, an emphasis on supporting exports to ensure that the increased international competitiveness generated by the weaker Rupiah is maximized, on increasing investment efficiency, and on supporting, and enhancing, FDI inflows, is needed.

The 2014 Budget maintains a prudent stance and coordination with monetary policy but may face challenges on both the revenue and expenditure sides, notably from higher Rupiah-denominated fuel subsidy costs.

Poverty in Indonesia is continuing to decline, but at a slower pace, and there is a strong likelihood of official targets for poverty rates for 2014 being missed.

Indonesia’s labor market, the fourth largest in the world, continues its structural transformation, adding 20 million net new jobs from 2001 to 2012, but facing the ongoing challenge to increase further high value-added formal employment.

The December 2013 edition of the IEQ also previews new survey evidence on local governance capacity, with democratization and decentralization having placed local governance at the forefront of effective service delivery and resource allocation in Indonesia.